Value Investing

Charlie Munger: “Why Were Warren Buffett And His Creation, Berkshire Hathaway, So Unusually Successful?”

Last week the Daily Journal held its 2018 General Meeting chaired by Charles Munger. One of the key takeaways for us as small investors was when Munger said:

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“I do think that a very smart man who’s patient and aggressive in combination, is willing to work hard, to root around in untraveled places like thinly traded stocks and other odd places. I do think a person with a lot of shrewdness, working with a small amount of capital, can probably earn high returns on capital even today. Generally speaking, I would say, if you’re shrewd enough with small sums of money, I think you can compound pretty well.”

So it seems that there are still opportunities for small investors who are shrewd and patient. Last week’s meeting reminded us of the 2007 Wesco Annual Meeting in which Munger took the unprecedented step of answering a question that he had chosen for the audience. His question was, “Why were Warren Buffett and his creation, Berkshire Hathaway, so unusually successful?”

Here is an excerpt from that meeting:

I want to do something I haven’t done before. I feel obligated because so many of you came from such great distances, so I’ll talk about a question I’ve chosen, one that ought to interest you: Why were Warren Buffett and his creation, Berkshire Hathaway, so unusually successful? If that success in investment isn’t the best in the history of the investment world, it’s certainly in the top five. It’s a lollapalooza.

Why did one man, starting with nothing, no credit rating, end up with this ridiculous collection of assets: $120 billion of cash and marketable securities, all from $10 million when Warren took over, with about the same number of shares outstanding. It’s a very extreme result.

You’ll get some hints if you read Poor Charlie’s Almanack, which was created by my friend Peter Kaufman, almost against my will – I let him crawl around my office when I wasn’t there. He said it would make a lot of money, so he put up $750,000 and promised that all profits above this would go to the Huntington Library [one of Munger’s favorite charities]. Lo and behold, that’s happened. He got his money back, and the donee’s receiving a large profit. Some people are very peculiar, and we tend to collect them.

A confluence of factors in the same direction caused Warren’s success. It’s very unlikely that a lollapalooza effect can come from anything else. So let’s look at the factors that contributed to this result:

The first factor is the mental aptitude. Warren is seriously smart. On the other hand, he can’t beat all comers in chess blindfolded. He’s out-achieved his mental aptitude. Then there’s the good effect caused by his doing this since he was 10 years old. It’s very hard to succeed until you take the first step in what you’re strongly interested in. There’s no substitute for strong interest and he got a very early start.

This is really crucial: Warren is one of the best learning machines on this earth. The turtles who outrun the hares are learning machines. If you stop learning in this world, the world rushes right by you. Warren was lucky that he could still learn effectively and build his skills, even after he reached retirement age. Warren’s investing skills have markedly increased since he turned 65. Having watched the whole process with Warren, I can report that if he had stopped with what he knew at earlier points, the record would be a pale shadow of what it is.

The work has been heavily concentrated in one mind. Sure, others have had input, but Berkshire enormously reflects the contributions of one great single mind. It’s hard to think of great success by committees in the investment world – or in physics. Many people miss this. Look at John Wooden, the greatest basketball coach ever: his record improved later in life when he got a great idea: be less egalitarian. Of 12 players on his team, the bottom five didn’t play – they were just sparring partners. Instead, he concentrated experience in his top players. That happened at Berkshire – there was concentrated experience and playing time.

This is not how we normally live: in a democracy, everyone takes turns. But if you really want a lot of wisdom, it’s better to concentrate decisions and process in one person.

It’s no accident that Singapore has a much better record, given where it started, than the United States. There, power was concentrated in one enormously talented person, Lee Kuan Yew, who was the Warren Buffett of Singapore.

Lots of people are very, very smart in terms of passing tests and making rapid calculations, but they just make one asinine decision after another because they have terrible streaks of nuttiness. Like Nietzsche once said: “The man had a lame leg and he’s proud of it.” If you have a defect you try to increase, you’re on your way to the shallows. Envy, huge self-pity, extreme ideology, intense loyalty to a particular identity – you’ve just taken your brain and started to pound on it with a hammer. You’ll find that Warren is very objective.

All human beings work better when they get what psychologists call reinforcement. If you get constant rewards, even if you’re Warren Buffett, you’ll respond – and few things give more rewards than being a great investor. The money comes in, people look up to you and maybe some even envy you. And if you buy a whole lot of operating businesses and they win a lot of admiration, there’s a lot of reinforcement. Learn from this and find out how to prosper by reinforcing the people who are close to you. If you want to be happy in marriage, try to improve yourself as a spouse, not change your spouse. Warren has known this from an early age and it’s helped him a lot.

So this is a lesson for you to draw on – and I think almost anybody can draw those lessons from Warren’s achievement at Berkshire. The interesting thing is you could go to the top business schools and none are studying and teaching what Warren has done. There’s nothing nutty in the hard sciences, but if you get into the soft sciences and the liberal arts, there’s a lot of nuttiness, even in things like economics. Nutty people pick people like themselves to be fellow professors. It gets back to what Alfred North Whitehead talked about: the fatal unconnectedness of academic disciplines. When people are trying to recruit people to be PhDs in their subjects – the results are often poor.

On the other hand, if you have enough sense to become a mental adult yourself, you can run rings around people smarter than you. Just pick up key ideas from all the disciplines, not just a few, and you’re immensely wiser than they are. This is not a great social advantage, however, as I can tell you from experience of the early Charlie Munger. To meet a great expert in a field and regard him as a malformed child is not a winning social grace. I got a lot of hard knocks when I was young. You could say I was forced into investing. The world will not ordinarily reward you for correcting other people in their area of expertise.

You can read the notes from the 2007 Wesco Annual Meeting here.

You can also read a transcript of the 2018 Daily Journal Annual Meeting here.

For more articles like this, check out our recent articles here.

Article by Johnny Hopkins, The Acquirer's Multiple